Commentary

Euro collapse needn’t torpedo global economy

Commentary: U.K., U.S., China would survive a European depression

By

MatthewLynn

LONDON (MarketWatch) — It isn’t hard to understand why the financial markets are going into the summer looking shaky. Fresh Greek elections are set for next month, and may trigger a disorderly exit from the single currency. There is a slow-motion run on the Spanish banking system underway. Contagion from the euro crisis threatens to spill out into the rest of the world.

Switch on the television, or log on to a news website, and there will be a gaggle of economists queuing up to warn you that the euro crisis threatens global stability. August bodies such as the International Monetary Fund or G-8 constantly threaten that the euro
EURUSD, -0.0441%
has to be rescued — or else the world economy faces ruin.

But hold on. It’s not necessarily true. If the euro collapses, it might well be a big financial event. Stock markets will wobble, and some banks will lose a lot of money. But it needn’t necessarily torpedo the global economy.

“After the Asian crisis of 1997, everyone was getting out of that market,” said David Marcus, CEO of Evermore Global Advisers and manager of its Global Value Fund. “But if you’d gone in then, you’d have made a lot of money. The same might well be true in Europe.”

True enough. If you step back a minute and look at the figures, then the prospect of a euro collapse does not look quite so scary.

Of course, the euro zone is a big economic bloc. With 330 million people, in what are mostly highly developed economies, it could hardly fail to be. But the rest of the world has grown a lot richer in the last decades, and the euro zone now accounts for just 14.5% of global gross domestic product, according to figures from the European Central Bank. That compares to 19.5% for the U.S. So we’re talking about less than a sixth of the world economy here. And of course, whilst the euro zone is a big trading bloc, it mostly trades with itself, like most other economic areas.

So let’s take a worst-case scenario. A collapse of the single currency, followed by a deep depression across Europe — perhaps a 30% contraction in GDP, similar to what the U.S. suffered in the early 1930s. What kind of impact might that have?

Take the U.K., undoubtedly the most exposed major nation; the euro zone is right next to Britain and is its major market. The euro zone accounts for 47% of the U.K.’s exports. And exports account for 27% of U.K. GDP. So, roughly 13% of the economy is dependent on selling stuff to the members of the single currency, a significant but not exactly overwhelming chunk of the economy.

Not all of that will collapse even in a deep depression. The U.K.’s main physical exports are defense equipment, cars, whisky and pharmaceuticals. Its main invisible exports are banking, insurance and legal services. The car industry will suffer for certain. Guns and drugs will do all right — people need those no matter how grim the economy. Financial services may actually improve – someone will have to trade those new currencies, and who better than the dealers of the City of London? As for the Scotch distilleries, they will probably do all right as well — they may well need a few stiff ones over at the ECB as the deal goes down. So, while the U.K. will take a hit, it will pull through.

The U.S. is significantly less exposed. The euro zone is the U.S.’s third largest export market, accounting for 15% of American goods and services sold aboard. But exports only account for a small percentage of the U.S. economy. In total, only 2.1% of U.S. GDP depends on exports to Europe, according to the U.S. Commerce Department. Even if they were halved, it need hardly be fatal. And many of those exports will be spare parts for Boeing planes and Hollywood movies — both of which will hold up all right.

Much the same will be true of other big economies such as Japan or China. In total, imports account for 22% of euro-zone GDP, and euro-zone imports account for about 3% of global GDP. Even if they disappeared completely, and no one could sell anything to Europe any more, the world might only lose 3% of output. The IMF estimates that the world economy will grow by 3.5% this year. Even on the very worst possible scenario — in which exports to Europe shrink to zero — we’re only talking about one year of growth vanishing.

We keep hearing that a euro collapse is a potential “Lehman moment.” But the reason Lehman triggered a catastrophic drop in global trade was because the world was unprepared for it, and it led to a collapse in credit. The banking system can hardly be unprepared for the collapse of the euro. What else has everyone been worrying about for the last two years?

The financial markets are the most globalized sector of the world economy, and the people within them have a natural-enough tendency to assume every other industry operates as internationally as it does. But in fact most economies remain mainly national and regional.

The collapse of the euro would be a serious event for the world economy. But it need not be fatal. So long as the financial consequences could be contained, and the rest of the world’s banks kept on making loans to companies, the wheels would keep turning.

Two important points come out of that.

First, while stock markets might be lower on fears of a euro-zone breakup, they don’t need to collapse. True, company profits will suffer, and that’s a good reason for marking down equities by 20%. But a 50% drop in values is excessive.

And global leaders shouldn’t be blackmailed by the IMF and others into believing they have to prop up the euro. There is no point in throwing endless billions at supporting a currency that doesn’t work. There are far more useful things to do with the money.

The euro’s collapse wouldn’t matter as much as everyone says it would.

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